Markets & Finance

S&P 500 Closes at New High

A new record close for the Standard & Poor's 500 index on Friday attested to the optimism that greeted the September nonfarm payrolls data and the big upward revision for August. Bulls showed they were willing to sacrifice diminished chances of further Fed easing for a stronger read on the U.S. economy.

Major U.S. stock indexes ended higher Friday, with the gains fueled not only by the payroll numbers that reduce the risk of a recession, but also a blowout earnings report from Research in Motion (RIMM). Negative profit news from big financial firms Merrill Lynch (MER) and Washington Mutual (WM) didn't appear to have a significant impact on sentiment.

On Friday, the Dow Jones industrial average closed 91.70 points, or 0.66%, higher at 14,066.01, after backing off a new intraday high above 14,115. The broader S&P 500 index hit a new intraday high of 1,560 before slipping slightly to end up 14.75 points, or 0.96%, at a new record close of 1,557.59. The tech-heavy Nasdaq index jumped 46.75 points, or 1.71%, to 2,780.32, a six and three-quarter year high.

Financials stocks were leading the broad-based rally, led by Merrill Lynch and Washington Mutual. Retailers also got a lift from the jobs numbers -- as investors bet that consumers will spend money as long as they have jobs.

The U.S. economy added 110,000 jobs in September, solidly within the band that the market was hoping for. The sharp revision in the August data to a gain of 89,000 jobs from an initial 4,000 decline -- mostly from new government jobs -- showed the economy is in much better shape than people had believed. The September unemployment rate notched up to 4.70% from 4.64% in August.

In September, a 106,000 gain in private service jobs and a 37,000 increase in government payrolls more than compensated for losses of 18,000 manufacturing jobs and 14,000 construction jobs. Hourly earnings rose by a hefty 0.4%, putting year-over-year earnings growth at 4.3%, which matches the cyclical high set in April, 2006.

According to Fed funds futures, chances that the Federal Reserve might cut interest rates again at the end of the month has been lowered to below 50%, from around 75% before the employment report was released.

Early strengthening of the U.S. dollar against the euro soon evaporated, however, indicating that some in the market believe the Fed could still cut rates on Halloween.

Another batch of profit-warnings-cum-asset-writedowns in the financial industry added to the news earlier this week from Citigroup (C) and others, generating more confidence that most of the fallout from the subprime meltdown has been seen. And once again, instead of being hammered, stocks were rewarded by investors showing they preferred negative news to uncertainty.

The 1% growth rate, year over year, in non-governmental payrolls is well below the run rates of 2005 and 2006, which belies the case being made for a re-accelerating economy that will generate job growth, said Joe Battipaglia, market strategist at Stifel Nicolaus & Co. in Philadelphia. He said he doesn't accept the forecasts for double-digit earnings growth in the next few quarters.

The retreat in consumer spending that economists are worried about is already clear from the 30% drop in aggregate demand for credit, including mortgage debt, from the peak in early 2006, Battipaglia said. Yet the stock market chooses to look past that and to focus instead on the notion that the worst of the credit crisis is past now that banks are announcing massive asset writeoffs, he added. It's highly unlikely that banks will start lowering their lending standards or that the government will unveil a bailout plan for distressed homeowners any time soon, he said.

That means it will be harder for the stocks markets to move much higher from current levels, as the economy doesn't have the momentum to warrant it, he said. Once the market starts to focus on what the companies in the S&P 500 index can earn in the next 12 months, investors will realize that the double-digit growth targets aren't realistic, he added.

So while none of the economic data due out next week is likely to sway market opinion on equities, more negative pre-announcements on quarterly earnings could have a damping effect, he said. The most important numbers next week will be September's producer price index and the consumer sentiment index, both coming out on Friday, Oct. 12.

The substantial upward adjustment in August payrolls is causing observers to question whether the Fed would have eased rates to the degree it did on Sept. 18 if it had known the original number wasn't as bad as it was.

But Thomas Higgins, chief economist at Payden & Rygel, in a new research note pointed out that ongoing job cuts in the construction and manufacturing sectors, which are cyclically sensitive, "provide insight into how the underlying economy is performing and it is these sectors that generate jobs when the economy is on an upswing."

Fourth-quarter economic data could reflect the lingering impact of the credit crunch, with resets on adjustable-rate mortgages and a higher unemployment rate likely to slow consumer spending and convince the Fed to take further action before the end of the year, Higgins wrote.

Speaking in Philadelphia, Fed vice-chairman Donald Kohl said the Fed would continue to be "nimble in adjusting policy to promote growth and price stability," but said that credit would become less available to new homebuyers. He also explained that the decision to cut the Fed funds rate by a half-percentage-point instead of a quarter-point on Sept. 18 was to help offset the effects of tighter credit conditions and to encourage moderate economic growth rather than to cut the losses from the repricing of risk.

Crude oil for November delivery in New York rebounded from earlier pressure to trade 22 cents lower at $81.22 a barrel on Friday, as the U.S. dollar turned neutral, giving up gains made against the euro earlier in the day.

Among stocks in the news Friday, Research in Motion shares jumped 12.8% after it said it doubled its second-quarter earnings to 50 cents from 25 cents a share a year ago due to a sharp rise in revenue. The maker of the Blackberry expects revenue of $1.6 billion to $1.67 billion and earnings of 59 to 63 cents a share in the third quarter. Standard & Poor's raised its fiscal 2008 profit estimate to $2.18 a share and its target price to $100 but reaffirmed its hold rating, while Goldman Sachs raised its price target and added the stock to its conviction buy list.

Washington Mutual shares rose 2.2% after it said it expects its third-quarter profits to plunge 75% from a year ago on a weakening housing market and disruptions in the secondary mortgage market. The bank said it continues to have the liquidity and capital necessary to grow its business and support its current dividend. Standard & Poor's kept its hold rating.

Merrill Lynch said it expects to post a net loss of up to 50 cents a share in the third quarter after an estimated writedown of $4.5 billion in collateralized debt obligations, subprime loan and leveraged buyout commitments. Shares were up 2.5%.

Later in the day Sovereign Bancorp (SOV) said it had boosted the provision for pre-tax credit losses in the third quarter to between $155 million and $165 million from a prior range of $104 million to $114 million. It also said it will take roughly $35 million in pre-tax charges for losses related to loans provided to mortgage companies that have been defaulted on and loan portfoios classified as loans held for sale. Shares finished 1.9% higher.

Leap Wireless International (LEAP) shares fell 8.4%, most likely on the heels of a third-quarter pre-announcement from rival wireless provider MetroPCS (PCS) that said attrition by customers had risen to 5.2%. S&P upheld its hold rating on the stock and said it thinks investors believe LEAP will show similar results, leading to lower revenue and earnings after interest and taxes. Also, S&P sees continued weakness at PCS further delaying a potential merger between the two carriers. In September, LEAP rejected an unsolicited stock-based merger proposal from PCS.

Alcoa Inc. (AA) shares were up 3.0% on news the company is going ahead with the sale of its Packaging and Consumer business. Alcoa said it's also near a definitive agreement to sell its Automotive Castings business and should close the transaction by yearend. It expects to take a total of $845 million in restructuring and impairment charges in the third quarter. S&P raised its target price to $40 from $36 and reiterated its hold rating.

Barclays PLC (BCS) said it has withdrawn its offer to acquire ABN Amro (ABN). Barclays will restart its share buyback program without the restrictions specific to the ABN offer, a Dow Jones report said. Under the new, restarted program, up to £1.55 billion remains available to purchase up to 196 million shares. Barclays was up 1.3%.

Asian markets ended mixed. In Japan, the Nikkei 225 edged down 0.16% to 17,065.04. In Hong Kong, the Hang Seng index advanced 3.18% to 27,831.52. The Shanghai composite index was closed all week for a Chinese national holiday.

Treasury Market

Treasury yields surged as bond prices pulled back on the strength of the payrolls report and lesser chances of recession. The 10-year note dropped 1-00/32 to 100-28/32 for a yield of 4.64%, and the 2-year bond slipped 06/32 to 99-27/32 for a yield of 4.07%. The 30-year bond fell 1-24/32 to 102-02/32 for a yield of 4.87%.

The Treasury market will be closed Monday in observance of Columbus Day.